Description of business

The Company is a holding company whose primary business operations are conducted through its subsidiaries located in the PRC’s Henan Province. Prefecture is located in Guizhou Province and is manufacturing corundum materials, a major raw material for monolithic refractory. Through its operating subsidiaries, the Company produces and markets a broad range of monolithic refractory, functional ceramics, fracture proppants, fine precision abrasives, and corundum materials.

The principal raw materials used in the products are several forms of aluminum oxide, including bauxite, processed AI₂ O₃ and calcium aluminates cement, and other materials, such as corundum, magnesia, resin and silica, which are primarily sourced from suppliers located in the PRC. The production facilities of the Company, other than the Prefecture’s sub-processing factory located in Guizhou, are also located in Henan Province.

Refractories products allow steel makers and other customers to improve the productivity and longevity of their equipment and machinery. Functional ceramic products mainly include abrasive balls and tiles, valves, electronic ceramics and structural ceramics. Fracture proppant products are used to reach trapped pockets of oil and natural gas deposits, which lead to higher productivities of oil and natural gas wells. Due to their heat-resistant qualities and ability to function under thermal stress, refractories serve as components in industrial furnaces and other heavy industrial machinery. Corundum materials are major raw material for producing monolithic refractory. Fine precision abrasive is the Company’s new product that was commercially launched in the fourth quarter of 2009, and is used for slicing the solar-silicon bar and polishing the equipment surface. The Company’s customers include some of the largest steel and iron producers located in 25 provinces in the PRC, as well as in the United States and other countries in Asia, and Europe.

Summary of significant accounting policies

Basis of consolidation

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Summary of significant accounting policies (Cont’d)

Concentrations of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, restricted cash, trade, bills and other receivables. As of September 30, 2012 and December 31, 2011, substantially all of the Company’s cash and cash equivalents and restricted cash were held by major financial institutions located in the PRC and Hong Kong, which management believes are of high credit quality. With respect to trade and other receivables, the Company extends credit based on an evaluation of the customer’s financial condition. The Company generally does not require collateral for trade and other receivables and maintains an allowance for doubtful accounts of trade and other receivables.

Regarding bills receivable, they are undertaken by the banks to honor the payments at maturity and the customers are required to place deposits with the banks equivalent to a certain percentage of the bills amount as collateral. These bills receivable can be sold to any third party at a discount before maturity. The Company does not maintain allowance for bills receivable in the absence of bad debt experience and the payments are undertaken by the banks.

During the reporting periods, customers represented 10% or more of the Company’s condensed consolidated sales are:

Jilin Petroleum Group Company Ltd.

Shangdong Steel Co., Ltd. Rizhao Subsidiary

AMSAT International Limited

Shanghai Jolly Trading Co., Ltd.

Summary of significant accounting policies (Cont’d)

Recently issued accounting pronouncements (cont’d)

In September 2011, the FASB issued ASU 2011-09, “Compensation - Retirement Benefits - Multiemployer Plans (Subtopic 715 - 80)”. The amendments in this update require additional disclosures about an employer's participation in a multiemployer plan. ASU 2011-09 is effective for annual periods for fiscal years ending after December 15, 2011, and early adoption is permitted. ASU 2011-09 should be applied retrospectively for all prior periods presented. The adoption of this ASU has no material impact on the Company’s condensed consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210)”. The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments retrospectively for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU has no material impact on the Company’s condensed consolidated financial statements.

In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220)”. The amendments in this update supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”, to effectively defer only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early application is permitted. The adoption of this ASU has no material impact on the Company’s condensed consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02 on impairment testing for indefinite-lived intangible assets. This ASU amends FASB Codification Topic 350, Intangibles-Goodwill and Other to allow, but not require, an entity, when performing its annual or more frequent indefinite-lived intangible asset impairment test, to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount. ASU2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company is currently evaluating ASU 2012-02. The adoption of this ASU will not have a material impact on the Company’s condensed consolidated financial statements.

In October 2012, the FASB issued ASU 2012-04, “Technical Corrections and Improvements”. The amendments in this update cover a wide range of Topics in the Accounting Standards Codification. These amendments include technical corrections and improvements to the Accounting Standards Codification and conforming amendments related to fair value measurements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The Company is evaluating the impact of this ASU and does not expect its adoption to have a significant impact on the Company's condensed consolidated financial statements.

Restricted cash and bills payable

Bank deposits held as collateral for bills payable (Note 5a)

Bank deposits held as collateral for bank loans (Note 13)

Other (Note 5b)

The Company is requested by certain suppliers to settle amounts owed to such suppliers by the issuance of bills through banks for which the banks undertake to guarantee the Company’s settlement of these amounts at maturity. These bills are interest free and would be usually matured within six months from the date of issuance. As collateral security for the banks’ undertakings, the Company is required to pay the bank charges as well as maintaining deposits with such banks amounts equal to 50% or 100% of the bills’ amounts issued.

The amount was held by a third party due to the dispute with one supplier at Prefecture and was settled in the third quarter of 2012.

Trade receivables, net

Trade receivables

Allowance for doubtful accounts

Balance at beginning of period

Addition of doubtful debt expenses, net

Translation adjustments

Balance at end of period

Other receivables and prepayments, net and advances to senior management

Government grant receivables (Note 7a)

Loans to third parties (Note 7b)

Value added tax and other tax recoverable

Deposits for purchase of raw materials

Other deposit

Prepayments

Other receivables

Advances to staff (Note 7d)

Allowance for doubtful accounts

Advances to senior management (Note 7b)

Balance at beginning of period

Addition of doubtful debt expenses, net

Translation adjustments

Balance at end of period

As of September 30, 2012, government grant receivables represented incentive bonus of $397,906 from the local government for successful back-door listing and good performance by Refractories.

The loans to third parties mainly represent the loans to companies and government entity which have business connections with the Company. The amounts are interest-free, unsecured and repayable on demand.

The advances to senior management are mainly for handling sourcing activities and for travel and other expenses in the ordinary course of business.

Other investment represented RMB5 million (equivalent to $790,500) that the Company paid in August 2012 to acquire minority equity interest in Rural Credit Cooperatives of Gongyi, Henan (RCCG), a credit union established and engaged in providing credits in the rural areas in Gongyi, Henan. The transaction was completed on September 29, 2012 and subsequently transferred to an independent third party at its original cost of RMB5 million on November 16, 2012.

The amounts mainly represent staff drawings for handling sourcing and logistic activities, and those normal operations for the Company in the ordinary course of business.

Inventories, net

Raw materials

Work-in-progress

Finished goods

Allowance for obsolete inventories

No allowance for obsolete inventories was recognized in the cost of goods sold during the nine months ended September 30, 2012 and 2011.

Deposit for acquisition of a non-consolidated affiliate, net and investment in a non-consolidated affiliate

The Company paid RMB 15 million (equivalent to $2.37 million) in August 2010 to acquire 24.5% equity interest in Yili YiQiang Silicon Limited ("Yili"), a company established in the PRC and engaged in manufacturing and trading of silicon carbide. Due to some unexpected administrative difficulties in the completion of the acquisition, the aforesaid investment amount paid was only recognized as deposit as the ownership, risks and rewards of 24.5% equity interest in Yili had not been transferred to the Company as of December 31, 2011. The acquisition was completed on May 28, 2012 and the deposit was recognized as investment in a non-consolidated affiliate at that date.

The management opined that there was an indication of impairment as the financial position of Yili deteriorated subsequent to the payment of deposit. Based on the impairment review performed by the management with reference to the financial position of Yili as of December 31, 2011, an impairment loss of $1,248,804 was recognized in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2011 as the management assessed the probability of recovering the whole carrying value of the deposit was unlikely.

Initial cost

Less: Impairment charge

Translation adjustments

Less: Recognized as investment in a non-consolidated affiliate

Net

Intangible assets, net and goodwill, net

Unpatented technology (Note 10a)

Accumulated amortization

Translation adjustments

Net book value

Less: Impairment charge

Net

Goodwill (Note 10b)

Less: Impairment charge

Net

During 2007, Refractories entered into a contract with an independent third party to purchase unpatented technology in relation to the production of mortar, at a cash consideration of $342,750. This consideration was mutually agreed between Refractories and such third party and this unpatented technology can be used for an unlimited period of time. Since its acquisition, an annual impairment review was performed by management and it was stated at cost less any impairment losses. In 2011, the expected useful life of the unpatented technology was reviewed and can be used up to 2015. Unpatented technology is stated at cost less any accumulated amortization and any identified impairment losses. Based on the result of the impairment review performed by the management at the end of 2011, the management assessed the probability of recovering the carrying value of the unpatented technology was unlikely and the intangible asset was considered fully impaired.

During the nine months ended September 30, 2012 and 2011, the amortization charge was nil and $57,638 respectively.

The goodwill was identified upon the acquisition of 100% equity interest in Prefecture, which represented the excess of the purchase price of $875,400 over the fair value of acquired identified net assets of Prefecture of $434,311 at the time of acquisition on June 12, 2008. Since its acquisition, annual impairment reviews have been performed by management. Based on the result of the impairment review performed by the management at the end of 2011, the management assessed the probability of recovering the carrying value of the goodwill was unlikely and the goodwill was considered fully impaired.

Property, plant and equipment, net

During the reporting periods, depreciation is included in:

During the nine months ended September 30, 2012, property, plant and equipment with carrying amounts of $204,061 was disposed of at a consideration of $88,538 to offset trade payable balance, resulting in a loss of $115,523 . During the nine months ended September 30, 2011, property, plant and equipment with carrying amounts of $101,191 was disposed of at a consideration of $68,991, resulting in a loss of $32,200.

Capitalized interest for the nine months ended September 30, 2012 and 2011 was immaterial.

Construction in progress

Construction in progress mainly comprises capital expenditure for construction of the Company’s new offices and factories.

Non-interest-bearing loans

The loans represent interest-free and unsecured loans from the Company’s business associates and a government entity and are repayable on demand.

Collateralized short-term bank loans

Guarantee executed by Mr. Shunqing Zhang, the Chairman and CEO of the Company and a shareholder;

Guarantee executed by business associates (Note 18b) up to the amount of $26,086,500;

Land use rights with carrying amount of $3,096,896;

Bank deposits of $33,780,700 (Note 5); and

Bills receivable of $5,005,446.

Loan from a third party

The loan is interest-bearing at 18% per annum, unsecured and fully settled on October 25, 2012.

Finance costs

Income taxes

UNITED STATES

The Company is incorporated in the United States of America (“U.S.”) and is subject to U.S. tax law. No provisions for income taxes have been made as the Company has no U.S. taxable income for reporting periods. The applicable income tax rate for the reporting periods is 34%. The Company has not provided deferred tax on undistributed earnings of its non-U.S. subsidiaries as of September 30, 2012, as it is the Company's current policy to reinvest these earnings in non-U.S. operations.

Income taxes (Cont’d)

BVI

GengSheng International and Smarthigh were incorporated in the BVI and are not subject to income taxes under the current laws of the BVI.

PRC

The PRC’s legislative body, the National People’s Congress, adopted the unified Corporate Income Tax Law (“CIT Law”) on March 16, 2007. This new tax law replaces the then separate income tax laws for domestic enterprises and foreign-invested enterprises and became effective on January 1, 2008. Under the new tax law, a unified income tax rate is set at 25% for both domestic enterprises and foreign-invested enterprises. However, there will be a transition period for enterprises, whether foreign-invested or domestic, that are currently receiving preferential tax treatments granted by relevant tax authorities. Enterprises that are subject to an enterprise income tax rate lower than 25% may continue to enjoy the lower rate and will transit into the new tax rate over a five year period beginning on the effective date of the CIT Law. Enterprises that are currently entitled to exemptions for a fixed term will continue to enjoy such treatment until the exemption term expires. Preferential tax treatment will continue to be granted to industries and projects that qualify for such preferential treatments under the new tax law.

Pursuant to the income tax rules and regulations of the PRC, provision for PRC income tax of the PRC subsidiaries is calculated based on the following rates : -

Entities entitled to a tax holiday in which they are fully exempted from the PRC enterprise income tax for 2 years starting from their first profit-making year after netting off accumulated tax losses, followed by a 50% reduction in the PRC enterprise income tax for the next 3 years (“tax holidays”). Any unutilised tax holidays will continue until expiry while tax holidays were deemed to start from January 1, 2008, even if the entity was not yet making profit after netting off its accumulated tax losses. Duesail is in the fifth year of tax holidays in 2012. Refractories was in the fifth year of tax holidays in 2009 and starting from the fiscal year 2010, Refractories is subject to enterprise income tax at unified rate of 15% for three years due to its engagement in an advanced technology industry and has passed the inspection of the provincial high-tech item. The relevant authority granted it a certificate during 2008 and renewed it during 2011. Starting from the fiscal year 2011, High-Temperature is subject to enterprise income tax at unified rate of 15% for three years due to its engagement in an advanced technology industry. The relevant authority granted it a certificate during 2011.

(Loss) income per share

During the reporting periods, all the potential dilutive shares were not included in the computation of diluted (loss) income per share because they were anti-dilutive. Accordingly, the basic and diluted (loss) income per share are the same.

Commitments and contingencies

The Company’s operations are subject to the laws and regulations in the PRC relating to the generation, storage, handling, emission, transportation and discharge of certain materials, substances and waste into the environment, and various other health and safety matters. Governmental authorities have the power to enforce compliance with their regulations, and violators may be subject to fines, injunctions or both. The Company must devote substantial financial resources to ensure compliance and believes that it is in substantial compliance with all the applicable laws and regulations.

The Company is currently not involved in any environmental remediation and has not accrued any amounts for environmental remediation relating to its operations. Under existing legislation, management believes that there are no probable liabilities that will have a material adverse effect on the financial position, operating results or cash flows of the Company.

The Company guaranteed the following debts of third parties, which is summarized as follows:-

Commitments and contingencies (Cont’d)

To maintain a good relationship with the local government of Gongyi City, the Company has been so requested to act as guarantor for bank loans granted to certain local government authorities and their controlled entity.

During the period, the Company has acted as guarantor for bank loans and bank acceptance bill granted to certain business associates. Certain of these associates also provided guarantees for bank loans to the Company (Note 13). None of our directors, director nominees or executive officers is involved in normal operation or investing in the business of the guaranteed business associates. All the business associates have a healthy record to pay back loans and bank acceptance bill on a timely manner, in the People’s Bank of China’s (Central Bank of China) credit rating system.

All the above guarantees have no recourse provision that would enable the Company to recover from third parties of any amounts paid under the guarantees and any assets held either as collateral or by third parties that the Company can obtain or liquidate to recover all or a portion of the amounts paid under the guarantees.

If the third parties fail to perform under their contractual obligation, the Company will make future payments including the contractual principal amounts, related interest and penalties.

As of September 30, 2012, the Company had capital commitments of $1,159,160 in respect of the acquisition of land use right; $988,982 in respect of the construction of new office buildings and workshops; and $478,719 in respect of the purchase of machinery, which were not contracted for and provided in these financial statements.

Commitments and contingencies (Cont’d)

In accordance with the PRC tax regulations, the Company’s sales are subject to value added tax (“VAT”) at 17% upon the issuance of VAT invoices to its customers. When preparing these condensed consolidated financial statements, the Company recognized revenue when the significant risks and rewards of ownership have been transferred to the buyer at the time when the products are delivered to and accepted by customers, and made full tax provision in accordance with relevant national and local laws and regulations of the PRC.

The Company follows the practice of reporting its revenue for PRC tax purposes when invoices are issued. In the local statutory financial statements prepared under PRC GAAP, the Company recognized revenue on an “invoice basis” instead of when the significant risks and rewards of ownership have been transferred to the buyer at the time when the products are delivered to and accepted by customers. Accordingly, despite the fact that the Company has made full tax provision in the condensed consolidated financial statements, the Company may be subject to a penalty for the deferred reporting of tax obligations. The exact amount of penalty cannot be estimated with any reasonable degree of certainty. The management considers it is very unlikely that the tax penalty will be imposed.

Defined contribution plan

The Company has a defined contribution plan for all qualified employees in the PRC. The employer and its employees are each required to make contributions to the plan at the rates specified in the plan. The only obligation of the Company with respect to the retirement plan is to make the required contributions under the plan. No forfeited contribution is available to reduce the contribution payable in the future years. The defined contribution plan contributions were charged to the condensed consolidated statements of operations and comprehensive loss. The Company contributed $345,910 and $314,827 for the nine months ended September 30, 2012 and 2011, respectively.

Segment information

The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company's chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company's reportable segments. Management, including the chief operating decision maker, reviews operating results solely by the revenue of monolithic refractory products, industrial ceramic products, fracture proppant products, fine precision abrasives and operating results of the Company. As such, the Company has determined that it has four operating segments as defined by ASC 280, “Segment Reporting”: refractories, industrial ceramic, fracture proppant and fine precision abrasives.

Adjustments and eliminations of inter-company transactions were not included in determining segment (loss) profit, as they are not used by the chief operating decision maker.

Three months ended September 30, (Unaudited)

Revenue from external customers

Segment (loss) profit

Segment information (Cont'd)

Nine months ended September 30, (Unaudited)

Revenue from external customers

Segment (loss) profit

Segment information (Cont'd)

Reconciliation is provided for unallocated amounts relating to corporate operations which are not included in the segment information.

Total consolidated revenue

Total (loss) income for reportable segments

Unallocated amounts relating to operations:

General and administrative expenses

Other income

(Loss) income before income taxes and

noncontrolling interest

Assets

Total assets for reportable segments

Other receivables

Cash and cash equivalents

Related party transactions

Apart from the information as disclosed in elsewhere in the condensed consolidated financial statements, the Company had no material transactions carried out with related parties during the reporting periods.

2011 Stock Incentive Plan (the “2011 Plan”)

At the annual meeting of stockholders of the Company held on September 28, 2011, the Company’s stockholders approved the 2011 Plan. The 2011 Plan authorized the Company to grant equity awards to directors, employees (including executive officers), consultants and other service providers, as more fully described and summarized in the Company’s Proxy Statement, which was included in the Schedule 14A filed with the Securities and Exchange Commission on August 15, 2011.

No awards were granted during the nine months ended September 30, 2012.

Subsequent events

The Company evaluated all events or transactions that occurred through the date the condensed consolidated financial statements were issued and determined that there is no material recognizable or subsequent events or transactions which would require recognition or disclosure in the condensed consolidated financial statements, except as disclosed in Note 7(c).